In 2020, several significant judicial decisions were rendered across Canada relevant to commercial lenders, businesses and restructuring professionals. This bulletin summarizes the core issues of importance in each case and provides status updates on the cases reported on in our January 2020 bulletin, Key Developments in Canadian Insolvency Case Law in 2019.
CHARACTERIZATION AND TREATMENT OF ELIGIBLE FINANCIAL CONTRACTS
Bellatrix Exploration Ltd. (Action No.
1901-13767)
Date of Decision: February 4, 2020
Bellatrix Exploration Ltd. (Bellatrix) obtained protection under
the Companies' Creditors Arrangement Act
(Canada) (CCAA). At the time of the CCAA filing, Bellatrix was
party to certain contracts with an energy producer (EP) for the
purchase and sale of natural gas (Contract). Bellatrix sought to
disclaim the Contract and cease delivery of natural gas to the
EP.
The EP argued that the disclaimer notice provided by Bellatrix was
invalid because the Contract constituted an eligible financial
contract (EFC) for the purposes of the CCAA. Under section 32(9) of
the CCAA, a debtor company is not permitted to disclaim contracts
that are EFCs. Pursuant to the express terms of the Contract, the
parties acknowledged that the Contract was an EFC.
Pursuant to regulations promulgated under the CCAA, a contract will
be considered an EFC if it is:
- a financial agreement;
- a financial agreement which is a derivatives agreement; or
- a derivatives agreement settled either by payment or delivery
which derivatives agreement either:
- trades on a futures, options exchange, board or other regulated market, or
- is the subject of recurrent dealings in the derivatives markets or in the over-counter securities or commodities markets.
In addition to arguing that the Contract was not properly
characterized as an EFC, Bellatrix argued that the court should
apply a "fair results" test under which it may determine
that, even if the form of contract constitutes an EFC, the court
may decline to characterize the contract as an EFC if it would be
unfair to do so.
The court found that fairness may enter the analysis when deciding
the threshold question as to whether an agreement meets the
definition of an EFC. Accordingly, the court concluded that it has
some latitude where the true characterization is at issue, and such
characterization has implications for the court's ability to
fulfil the objectives and purposes of the CCAA. The court, however,
drew a distinction between this approach and the proposition
advanced by Bellatrix that an agreement which clearly meets the
definition of an EFC may nevertheless be declared by the court not
to be one, on the basis of fairness. The court also noted that it
is problematic to suggest it should be permitted to substitute its
view of fairness for that reflected in Parliament's decision to
provide an exception to disclaimer for EFCs in section 32(9) of the
CCAA. The court rejected Bellatrix's argument, holding that to
disallow an agreement that meets the criteria of an EFC, to be
called an EFC, would be to allow the court to effectively rewrite
such agreement.
The court found that the Contract was both a financial agreement
and a derivatives agreement which should enjoy EFC status and was
therefore exempt from disclaimer.
Status
Leave to appeal this decision of the Court of Queen's Bench of Alberta was allowed on May 1, 2020. The appeal was heard by the Alberta Court of Appeal (ABCA) on October 22, 2020. At this time, no decision has been rendered.
Takeaway
Subject to appellate review, where a contract clearly meets the definition of an EFC, a court does not have the discretion to recharacterize the agreement to permit a disclaimer on the basis of fairness.
SECURITY POSITION OF ADVANCES IN EXCESS OF THE PRINCIPAL FACE AMOUNT OF A MORTGAGE
Forjay Management Ltd. v 625536 BC Ltd., 2020
BCCA 70
Date of Decision: February 27, 2020
In the context of a receivership proceeding commenced in respect of
a failed residential real estate development, a dispute arose
between multiple mortgagees in respect of the proceeds of
realization. The first and second mortgagees claimed that all funds
advanced by them to the borrower were secured by their mortgages in
priority to amounts advanced by a third mortgagee. The third
mortgagee submitted that amounts advanced by the prior registered
mortgagees in excess of the face amount of their respective
mortgages were not secured by the first and second mortgages and,
as a result, the third mortgagee had claims to the proceeds of
realization. The face amount of a mortgage is the principal amount
of the mortgage stated on the registered mortgage form.
The British Columbia Court of Appeal (BCA) affirmed the decision of
the Superior Court of British Columbia, finding that advances made
by first and second mortgagees in excess of the face amount of a
registered mortgage were secured and ranked in priority to a third
mortgage.
In doing so, the BCA considered the common law principle of
"tacking", and whether or not the obligation of a
borrower to repay money advanced under a first-in-time mortgage,
after a subsequent mortgage has been registered, takes priority
over such subsequent mortgage. The BCA found that where a priority
agreement exists among mortgagees, as was the case between the
second mortgagee and third mortgagee, it will govern the priority
of advances. It was a term of the second mortgage that the third
mortgagee would subordinate its loan to advances under the second
mortgage, and a priority agreement to that effect was registered on
the same day the second mortgage was entered into.
No such priority agreement existed between the first mortgagee and
third mortgagee. The BCA, however, held that even where such
priority agreement does not exist, a first mortgagee is able to
tack when it has no notice in the prescribed form of the existence
of a subsequent mortgage. In such circumstances, amounts advanced
in excess of the face amount of the mortgage will continue to be
secured. The form of notice required is governed by section 28(2)
of the Property Law Act (British Columbia) which requires
the subsequent mortgagee to provide formal written notice. Actual
notice will not suffice.
The first mortgagee had actual notice of the existence of the third
mortgage and was aware that the third mortgage was registered on
title. Actual notice was provided in the form of a passing
reference to the third mortgage in an email to the first
mortgagee's counsel. The BCA found that this notice was not
sufficient to constitute notice in compliance with the Property
Law Act (British Columbia).
Accordingly, the first mortgagee was found not to have had notice
for the purposes of tacking and the full amount of the first
mortgage, including the advances in excess of the registered face
amount, were valid and the obligation of the borrower to repay such
amounts ranked in priority to the obligations secured by the third
mortgage.
Status
Leave to appeal this decision to the Supreme Court of Canada (SCC) was denied on October 1, 2020. This decision is now final.
Takeaway
In British Columbia, where a subsequent mortgagee wishes to limit the amount of debt that ranks in priority to it, the subsequent mortgagee must provide formal written notice of the existence of its mortgage to prior mortgagees in accordance with the requirements of the Property Law Act (British Columbia).
EFFECTIVENESS OF STATUTORY CONSTRUCTION LIEN PROVISIONS IN INSOLVENCY PROCEEDINGS
Urbancorp Cumberland 2 GP Inc. (Re) (2020),
2020 ONCA 197
Date of Decision: March 11, 2020
The Ontario Court of Appeal (OCA) considered the scope and
effectiveness of section 9(1) of the Construction Lien Act
(Ontario) (CLA) which creates a trust over sale proceeds of real
property in favour of unpaid contractors in the construction
industry that add value to such real estate by their provision of
work and materials. The CLA has now been superseded by the
Construction Act (Ontario); however, the CLA was the relevant
statute at the time.
In this case, a residential condominium developer filed a Notice of
Intention to file a proposal under the Bankruptcy and Insolvency
Act (Canada) (BIA) and subsequently continued its proposal
proceedings under the CCAA. Unsold units in a condominium project
the developer constructed were among its assets and were ultimately
sold during the CCAA proceeding. Pursuant to an order of the OCA
expanding its statutory powers, the sales agreements were entered
into by the court-appointed monitor and the proceeds of sale were
received directly by the monitor. The appellant unpaid contractors
supplied work and materials in respect of the sold units and were
owed significant sums. The appellants claimed that, pursuant to the
CLA, a trust arose over the proceeds of sale to the extent of the
amounts owing to them, giving them priority over these amounts
ahead of secured creditors.
The motion judge rejected the trust claim because the sale proceeds
were not received by the owners of the sold units directly and were
instead received by the monitor. The germane provision, section
9(1) of the CLA, contemplates a sale of property by an owner, and
not by a representative of the owner.
The OCA reversed the decision of the motion judge and confirmed the
effectiveness of section 9(1) of the CLA in insolvency proceedings.
In doing so, the OCA held that the fact that the agreements of
purchase and sale were entered into by the monitor and not by the
owner itself did not detract from the fact that the owners were
ultimately the vendors of the units.
The OCA also addressed the interaction of the provincial CLA with
the federal CCAA from the perspective of the doctrine of federal
paramountcy, which provides that where validly enacted provincial
legislation conflicts with validly enacted federal legislation, the
federal legislation governs, and the provincial legislation is
inoperative to the extent of the conflict. Based on federal
paramountcy, case law under the BIA holds that provincial statutory
deemed trusts are inoperative in a bankruptcy under the BIA.
However, to the extent the relevant provincial legislation creates
a true trust - as opposed to deeming that a trust exists - that
true trust survives bankruptcy, and funds impressed with that true
trust are available to beneficiaries of the trust and not the
general body of creditors. A true trust must satisfy the three
certainties: certainty of intention, certainty of subject matter
and certainty of object.
Citing prior SCC case law, the OCA concluded that section 9(1)
creates a trust that satisfies the three certainties and,
accordingly, a true trust which survives bankruptcy. Section 9(1)
identifies the subject matter of the trust as the value of the
consideration on a specific sale by the owner of its interest and
identifies the object of the trust as the unpaid contractors who
supplied work and material to the improvement which was sold.
Finally, section 9(1) creates the requisite certainty of intention
by deeming the creation of a trust and requiring that the trust
funds not be appropriated for any purpose inconsistent with the
trust. As the CCAA (unlike the BIA) does not generally render
statutory provincial deemed trusts invalid, to the extent the trust
would survive in a bankruptcy, the OCA held that it must also
continue to be effective in a CCAA case.
The OCA concluded that the trust created by section 9(1) is only
displaced by the doctrine of paramountcy if it conflicts with a
specific priority created under the CCAA, or an order giving effect
to that priority, such that paramountcy would require the trust to
be considered inoperative in whole or in part. As a matter of
paramountcy, super-priority charges, such as the charge granted for
debtor-in possession (DIP) financing in this case, take priority
over a provincial statutory trust. The section 9(1) trust therefore
yielded in priority to the DIP financing charge but was otherwise
operative as against the objecting secured creditors.
Status
The time to seek leave to appeal this decision to the SCC has expired and this decision is now final.
Takeaway
The trust created by section 9(1) of the CLA meets the requirements of a true trust under the general principles of trust law and will only be displaced by the doctrine of paramountcy if it conflicts with a specific priority created under the CCAA. The trust claim yielded in priority to the DIP financing charge. Where there is no conflicting priority, the trust will impress upon the sale proceeds from property to which an unpaid contractor has made contributions.
THE CLAIM OF A LANDLORD FOLLOWING A DISCLAIMER OF A REAL PROPERTY LEASE IN BANKRUPTCY PROCEEDINGS
Curriculum Services Canada/Services Des
Programmes D'Études Canada (Re), 2020 ONCA
267
Date of Decision: April 27, 2020
Pursuant to subsection 136(1)(f) of the BIA, a landlord is entitled
to a preferred claim (ranking junior to secured creditors but in
priority to the general body of unsecured creditors) for (i)
arrears of rent for a period of three months immediately preceding
the bankruptcy, and (ii) accelerated rent for a period not
exceeding three months following the bankruptcy, if entitled to
accelerated rent under the lease, to the extent of the realizable
value of assets on the premises under the lease.
In this case, following disclaimer of its lease, in addition to its
preferred claim, the landlord claimed repayment of certain tenant
inducements and the balance of its preferred claim for accelerated
rent, in excess of the realizable value of the assets on the
premises as a regular unsecured creditor.
The OCA confirmed that, in Ontario, the disclaimer of a lease by a
bankruptcy trustee brings the bankrupt's obligations under the
lease to an end. The landlord is limited to its preferred claim for
up to three months' accelerated rent in respect of the
unexpired term of the lease, to the extent of value of the assets
on the premises. To the extent such value is not sufficient, the
landlord is entitled to recover any unpaid balance of its preferred
claim as a regular unsecured creditor.
Status
The time to seek leave to appeal this decision to the SCC has expired and this decision is now final.
Takeaway
In Ontario, where a lease is disclaimed by a bankruptcy trustee, a commercial landlord has no claim for the unexpired term of its lease beyond its preferred claim for three months' accelerated rent, limited to the value of the assets on the premises, and an unsecured claim for any unpaid balance of its preferred claim beyond the value of the assets on the premises.
SCOPE OF A MONITOR'S POWERS
Arrangement relatif à 9323-7055
Québec inc. (Aquadis International Inc.) 2020 QCCA
659
Date of Decision: May 21, 2020
Aquadis International Inc. (Aquadis) imported and distributed
bathroom products, including faucets, to various retailers of the
ultimate customers in Quebec. Certain of the faucets distributed by
Aquadis were faulty and in 2015, Aquadis commenced proposal
proceedings under the BIA, which were continued under the CCAA, as
a result of subrogated claims against it by insurers. Shortly after
commencing insolvency proceedings, Aquadis began negotiating with
its retailers to arrive at a global settlement pursuant to which
the retailers would contribute to a litigation pool in exchange for
full releases from any liability arising as a result of the sale of
defective faucets.
A global settlement was not reached and in 2019, pursuant to its
expanded authority by court order, the monitor of Aquadis filed a
plan of compromise and arrangement. The plan provided for the
establishment of a litigation pool made up of all sums of money
collected by the monitor from third parties, including from certain
settling retailers, in exchange for full releases. The plan
included the power of the monitor to sue the non-settling retailers
on behalf of creditors for contribution to the litigation
pool.
The plan was unanimously approved by the creditors. The
non-settling retailers, however, opposed the plan. Nevertheless,
the Superior Court of Quebec approved the plan, emphasizing, among
other things, the fact that proceedings against the non-settling
retailers were aimed at maximizing Aquadis' assets, a proper
purpose recognized in case law. The court also emphasized that
recourse against the non-settling retailers was the only possible
avenue leading to a global resolution of Aquadis' liabilities.
As such, according to the court, the powers requested by the
monitor to sue the non-settling retailers were necessary to advance
the restructuring process and the only practical solution in the
circumstances.
The non-settling retailers appealed this decision, arguing that the
powers granted to the monitor under the plan were contrary to
section 23 of the CCAA, which sets out the powers and duties of
monitors and the principle of neutrality of the monitor.
The Quebec Court of Appeal (QCA) dismissed the appellants'
argument. Under section 23, the powers and duties of a monitor can
be expanded at the discretion of the court. Expansion of the
monitor's powers in this case was warranted as it was for the
purpose of maximizing creditor recovery, an objective squarely
within the spirit of the CCAA. The QCA also noted that statutory
remedies and powers available to bankruptcy trustees pursuant to
the BIA are also available to CCAA monitors, and that under the
BIA, a trustee can exercise rights not only for the benefit of the
debtor, but also for the benefit of creditors. Further, the
appellants were not creditors but third parties to whom the monitor
owed no duty. Finally, the creditors voted unanimously for the
monitor to exercise their rights against the appellants in the
context of the CCAA proceedings and, accordingly, the monitor was
acting in conformity with the collective will of the
creditors.
The QCA also noted that a monitor's requirement of neutrality
is not absolute, provided that the monitor is objective, unbiased
and pursuing legitimate CCAA objectives.
Status
The time to seek leave to appeal this decision to the SCC has expired and this decision is now final.
Takeaway
In appropriate circumstances, a monitor may be permitted to commence litigation for and on behalf of creditors to maximize the CCAA estate.
PARTIAL DISCLAIMER OF A CONTRACT
Yukon (Government of) v Yukon Zinc Corporation,
2020 YKSC 16
Date of Decision: May 26, 2020
Yukon Zinc, a mining corporation, was party to a master lease that
applied to approximately 570 items, including equipment, vehicles
and tools related to its mining operations. The receiver of Yukon
Zinc found that only 79 of the items subject to the master lease
were required for continuing the necessary care and maintenance and
environmental remediation of the mine. Thus, the receiver sought to
disclaim the portions of the master lease pertaining to the
unnecessary items. The counterparty to the master lease objected to
the partial disclaimer and asserted that partial disclaimer was not
permitted by law. The counterparty argued that the receiver had a
binary choice to either reject or maintain the contract as a
whole.
The Yukon Territory Supreme Court found that, while uncommon, it
has the authority to authorize partial disclaimer of a contract
pursuant to the discretionary authority granted to it in the BIA
and the Judicature Act (Yukon) in the appropriate circumstances.
The court emphasized that, in the circumstances, the receiver was
acting in good faith and considered the interests of all
stakeholders. The court also considered it significant that the
receiver was not operating the mine, and urgently required the
specifically identified items for the care and maintenance and
environmental remediation of the mine. The cost and time to replace
these essential items was unreasonable given the remote location of
the mine. The need to continue the care and maintenance and
remediation activities was immediate. The terms of the master lease
were onerous and not commercially reasonable in the circumstances.
Accordingly, the court permitted the partial disclaimer of the
master lease.
Status
The time to appeal this decision has expired and this decision is now final.
Takeaway
This case involved a unique set of facts involving health, safety and environmental concerns. The receiver was able to identify a subset of required leased equipment from an itemized list in a master lease for use and ascribe a value for the use of such essential items. Caution is warranted before purporting to apply this precedent to a different fact scenario.
APPOINTMENT OF A RECEIVER PURSUANT TO SECTION 243 OF THE BIA AND INTERACTION WITH THE CIVIL CODE OF QUEBEC
Séquestre de Media5
Corporation, 2020 QCCA 943
Date of Decision: July 20, 2020
Section 243(1) of the BIA authorizes a court to appoint a receiver
with respect to an insolvent person on application of a secured
creditor. Unlike the rules of court and other statutes of its
common law counterparts, the Civil Code of Quebec (CCQ)
does not provide for the appointment of a receiver. The only way to
appoint a receiver in Quebec is by application under the federal
BIA.
The secured creditor of Media5 Corporation brought such an
application before the Quebec Superior Court. At a contested
hearing, the court found that it was not possible to appoint a
receiver in Quebec, at the request of a secured creditor in order
to sell the property of a business, when the property is located
only in Quebec.
The secured creditor appealed the lower court decision.
The QCA considered the scope of section 243(1) of the BIA in
conjunction with the requirements of the CCQ regarding the exercise
of hypothecary rights and, in overturning the lower court decision,
concluded that a receiver could be appointed in Quebec pursuant to
section 243(1). The QCA noted, however, that the BIA provisions
regarding the appointment of a receiver should coexist and be
construed harmoniously with provincial property and civil rights
laws, including the security and mortgage provisions of the CCQ.
Accordingly, the appointment must comply not only with notice
periods prescribed by the BIA, but also with the requirements of
the CCQ regarding the exercise of a hypothecary right, namely, the
issuance and expiry of a 20-day notice (over moveable, (i.e.
personal), property) or 60-day notice (over immoveable, (i.e.
real), property).
Status
Media5 Corporation filed an application for leave to appeal this decision to the SCC on November 12, 2020 and a leave decision is pending.
Takeaway
The QCA affirmed that the remedy of a BIA receiver is available
in respect of property located only in Quebec. However, a secured
creditor must satisfy the notice requirements under both the BIA
and the CCQ before seeking such appointment. This leads to
inconsistent notice requirements for the application for the
appointment of a BIA receiver between Quebec and the common law
provinces.
For more information, please see our July 2020 Blakes Bulletin: Media5 Corporation: Quebec
Court of Appeal Confirms Course of Action to Appoint a
Receiver.
COMPROMISE OF TERM LOANS AND ASYMMETRICAL TREATMENT OF UNSECURED CREDITORS UNDER CBCA PLANS OF ARRANGEMENT
Re Sherritt International Corporation, 2020
ONSC 5822
Date of Decision: September 28, 2020
Sherritt International Corporation (Sherritt), a holding company of
various subsidiaries, applied for final approval of a plan of
arrangement under section 192 of the Canada Business
Corporations Act (CBCA). CBCA plans have become an attractive,
cost-effective alternative to a CCAA process for overleveraged
companies seeking to complete a balance sheet restructuring, as
opposed to a comprehensive operational restructuring, for which the
CBCA is not suited.
Two creditors objected to plan approval. The objecting creditors
provided a term loan to subsidiaries of Sherritt, which was then
guaranteed by Sherritt. The guarantee was secured by a pledge of
equity interests directly or indirectly owned by Sherritt in a
foreign joint venture mining operation. The objecting creditors
were placed in the same class for voting purposes as unsecured
noteholders, although the plan provided for differential treatment
between the two creditor groups. The plan provided, in pertinent
part, that the objecting creditors would become the owners of the
equity that had been pledged to them to secure the guarantee. The
unsecured noteholders would have their claims subordinated and the
face value of their claims reduced. Existing equity holders of
Sherritt itself were to remain unimpaired.
The objecting creditors claimed that (i) a term loan is not capable
of arrangement under the CBCA, and (ii) the plan was unfair because
(a) the objecting creditors, which held security in an equity
interest owned by Sherritt, were unfairly placed in the same voting
category as unsecured noteholders, and (b) the plan was
substantively unfair.
The court rejected the first ground of objection and found that
term loans are capable of arrangement under section 192 of the
CBCA. In rejecting this objection, the court emphasized the
importance of interpreting the CBCA broadly and liberally in the
context of a debt restructuring.
The court similarly disagreed that the plan was unfair. The court
applied the principles outlined in Re Canadian Airlines Corp.,
with respect to classification of creditors under the CCAA, and
found that the objecting creditors were appropriately placed in the
same voting category as the unsecured noteholders of Sherritt.
Although the objecting creditors held security against certain
equity interests directly or indirectly owned by Sherritt, the
court concluded that, like the unsecured noteholders, the objecting
creditors had unsecured claims against Sherritt. The court also
noted that fragmentation of the class would be contrary to the
facilitative purpose of the arrangement provisions of the CBCA. The
objecting creditors were unable to demonstrate that it was
impossible to consult with the unsecured noteholders with a view to
their common interest.
With respect to substantive fairness, the court was satisfied that
the plan was both fair and reasonable to the objecting creditors.
Under the terms of the plan, Sherritt's guarantee would be
extinguished and the objecting creditors would become the owners of
the equity interest previously pledged to them. Sherritt took the
position that the objecting creditors would be in the same position
following plan implementation that they would have been in had they
realized on their security in a liquidation. The objecting
creditors, however, took issue with the fact that, in this case,
the equity holders of Sherritt itself were not being diluted or
otherwise impaired. The objecting creditors noted that in a
liquidation, no value would be given to equity until the debt to
the objecting creditors was paid as equity was behind them in the
capital structure. The court held that this, in and of itself, did
not result in unfairness, including because the unsecured
noteholders that were having their debt subordinated and reduced
under the plan voted in favour of the plan by an overwhelming
majority.
Further, the court did not place significant value on the guarantee
that was being extinguished. As a holding company, Sherritt's
only value was held in its various subsidiaries, located in a
variety of different countries. Had the objecting creditors
retained the guarantee and been required to commence a lawsuit to
collect any outstanding deficiency, they would face a high degree
of complexity in enforcing their interests and small chance of
recovery.
The court assessed the compromise being made by the objecting
creditors against the necessity of the arrangement and found that
there was no better option available to Sherritt and its
stakeholders.
In considering the objections, the court also provided guidance on
fairness opinions issued by a financial advisor or investment
banker on the fairness of a proposed transaction. Such opinions are
commonly provided to a court as evidence in support of a
company's request to have a court approve steps that a
corporation proposes to take, including a plan of arrangement under
the CBCA. The court noted that the mere presence of a fairness
opinion is meaningless. Like any other evidence, its force lies in
its content and substance which must be carefully reviewed.
Status
This decision was not appealed and is final.
Takeaway
A term loan is a debt obligation capable of compromise under section 192 of the CBCA. The arrangement provisions of the CBCA, like the CCAA, should be broadly and liberally construed in the context of a debt restructuring. When considering fairness objections to the classification of creditors under the CBCA, the court will consider commonality of interest and the facilitative purpose of the arrangement provisions of the CBCA. When considering the substantive fairness of an arrangement, the court will consider the necessity of the arrangement against the compromise being made by creditors.
INCLUSION OF THIRD-PARTY RELEASES IN A CORPORATE PLAN OF ARRANGEMENT
Re iAnthus Capital Holdings Inc., 2020 BCSC
1442
Date of Decision: September 28, 2020
The Supreme Court of British Columbia (BCSC) considered whether the
plan of arrangement proposed by iAnthus Capital Holdings, Inc.
(iAnthus) pursuant to the Business Corporations Act (British
Columbia) (BCA) was fair and reasonable and should be approved. The
plan of arrangement was the product of negotiations between iAnthus
and its noteholders.
The plan of arrangement included a broadly drafted release that
would have had the effect of immunizing iAnthus and persons
presently or formerly associated with iAnthus from claims advanced
in several actions, and a permanent injunction enjoining "all
persons" from advancing any of the released claims. The
application for approval of the plan was opposed by the plaintiffs
in several of the pending actions, in part, on the basis that the
release and injunction were overbroad.
Counsel for certain of iAnthus' creditors submitted that a
common practice has developed by which arrangements under corporate
statutes are utilized to reorganize insolvent or nearly insolvent
corporations, such as iAnthus, as an expedient and less expensive
alternative to a CCAA proceeding. The CCAA, however, would not
provide the same possibility of value for shareholders. The
creditors' counsel submitted that lenders giving up debt for
equity, in circumstances where shareholders were obtaining value,
would demand third party releases of the kind they have become
accustomed to obtaining under the CCAA. Absent such releases,
lenders would not continue to support arrangements under corporate
statutes, depriving companies and shareholders of the advantages of
this restructuring option.
The BCSC first considered whether the plan was fair and reasonable
apart from the release and injunction. The BCSC concluded that it
was the best possible arrangement for shareholders of iAnthus
following a thorough and professional attempt to market itself and
its assets. Nevertheless, the BCSC declined to approve the plan due
to the inclusion of the release and injunction, finding that
although the plan was the best arrangement for shareholders, it
would result in unfairness to certain creditors.
The BCSC found that arrangements under corporate statutes are
distinct from those under the CCAA. Despite common terminology, the
CCAA and corporate statues operate differently. While the CCAA
expressly contemplates a comprehensive arrangement proposed with
all creditors, or a class of creditors, in which all affected
creditors have a say in whether it should be adopted, the BCA does
not provide for a comprehensive compromise of debt and related
voting rights.
The BCSC held that the BCA does not afford the BCSC the authority
to limit the rights of third parties who receive nothing from the
arrangement, and may be unaware of the arrangement, in order that
the company may be substantively protected from claims in existence
before the arrangement was proposed. In the BCSC's view, an
order limiting the rights of third parties to the arrangement could
only be justified where it was truly necessary and where the
substantive positions of third parties were protected. This bar was
not satisfied in this case. Accordingly, the presence of the
release, and associated injunction in the plan, rendered the
arrangement unfair and unreasonable.
This decision contrasts with the 2018 decision of the Ontario
Superior Court of Justice in Re Concordia International Corp. In
that case, the court approved a CBCA plan of arrangement that
included certain releases in favour of third parties on the basis
that the criteria for approval of third-party releases under the
CCAA were applicable and satisfied. The BCSC noted that even if it
were mistaken and the court possessed the power to extinguish third
party claims as part of a corporate arrangement, the release in
this particular case was not a fair and reasonable balancing of
interests.
Status
The time to appeal this decision has expired and this decision is now final.
Takeaway
The BCA does not provide the court with the authority to approve a plan of arrangement that limits the rights of third parties unless it is truly necessary to the arrangement and the substantive positions of the third parties are protected.
COURT CONFIRMS AUTONOMY OF LETTERS OF CREDIT, RULES LANDLORD MAY DRAW FOR FULL CLAIM AMOUNT
Re 7636156 Canada Inc, 2020 ONCA
681
Date of Decision: October 28, 2020
Following disclaimer of the lease by the bankruptcy trustee of
7636156 Canada Inc. (the Bankrupt), the bankruptcy trustee brought
a motion for determination of the amount that the Bankrupt's
landlord was entitled to draw down on a letter of credit provided
to the landlord as security for the Bankrupt's obligations
under the lease. The bankruptcy trustee argued that the landlord
was only entitled to draw on the letter of credit for three
months' accelerated rent, in accordance with the landlord's
preferred claim under the BIA.
The OCA confirmed that the obligations of an issuer to honour a
draw on a letter of credit are independent, third party obligations
which the issuing bank is obligated to honour when presented with
documents that, on their face, conform with the terms and
conditions of the letter of credit. Disclaimer of a lease only ends
rights and remedies of a landlord as against a bankrupt
tenant's estate and does not end the rights and remedies of a
landlord against third parties, including issuers of letters of
credit. Accordingly, the landlord was entitled to draw on the
letter of credit to the full extent of its damages for the
unexpired term of the lease.
Status
An application for leave to appeal this decision to the SCC was filed by the bankruptcy trustee on December 18, 2020 and the leave decision is pending.
Takeaway
The obligations of an issuer to honour a draw on a letter of
credit are independent, third party obligations, unaffected by
disclaimer of a lease by a bankruptcy trustee. While the claim of a
landlord in bankruptcy is limited, a landlord's claim for
damages for the unexpired term of its lease is not limited for the
purposes of a letter of credit.
For more information, please see our November 2020 Blakes Bulletin: Court Confirms Autonomy of
Letters of Credit, Rules Landlord May Draw for Full Claim
Amount.
REVERSE VESTING ORDERS
In 2020, reverse vesting orders (RVOs) were used with increased
prevalence as a tool to facilitate restructurings. An RVO allows
for the transfer of liabilities or unwanted assets out of the
debtor company into a newly formed entity, or existing subsidiary,
prior to transfer of the shares of the existing debtor company to a
purchaser. The result is to remove anything a potential purchaser
may not want from the acquired entity, all without a creditor
vote.
It appears that an RVO was first used in the CCAA proceeding of T.
Eaton Company Limited (Eatons) in 1999 to vest out certain
liabilities of Eatons before the amalgamation of Eatons and Sears
Canada Inc. (Sears). The RVO allowed Sears to retain the benefit of
Eatons' tax losses. Similarly, in 2015, an RVO was used in the
CCAA proceeding of Plasco Energy Group Inc. (Plasco) to allow the
secured creditors that entered into a transaction with Plasco to
retain the benefit of its tax losses. Prior to October 2019, these
appear to be the only instances where an RVO was used.
The 2020 decisions highlighted below underscore the growing
popularity of RVOs.
Arrangement relatif à
Nemaska Lithium inc., 2020 QCCA 1488
Date of Decision: November 11, 2020
The CCAA debtors were involved in the development of a lithium
mining project in Quebec.
In January 2020, the CCAA court (the Quebec Superior Court)
approved the sale or investment solicitation process (SISP) on an
unopposed basis. The SISP resulted in the acceptance of an offer
that was made subject to the condition that an RVO be issued
providing for the acquisition of the shares of the debtor
companies. The RVO would allow the prospective purchaser to
continue to carry on the operations of the debtor companies in a
highly regulated environment by maintaining their existing permits,
licenses, authorizations, essential contracts and fiscal
attributes. Liabilities not to be assumed by the purchaser were to
be vested out of the acquired companies.
Two shareholders, one of whom was also a creditor, objected to the
approval of the RVO on multiple grounds, including the court's
lack of authority to grant a vesting order for anything other than
a sale or disposition of assets, and the impossibility under the
CCAA for debtor companies to emerge from CCAA outside of a plan of
compromise or arrangement, approved by creditors and the
court.
The CCAA judge granted the RVO, noting the purpose and efficiency
of the RVO in maintaining the going concern operations of the
debtor companies, the remedial objective of Canadian insolvency
laws, and the important role and wide discretion of the CCAA
supervising judge. The CCAA judge also considered the criteria
pursuant to section 36 of the CCAA as relevant to the granting of
an RVO, which lists the factors a court should consider with
respect to the disposition of assets and concluded that the
criteria were met. The objecting parties sought leave to
appeal.
The QCA dismissed the application for leave to appeal the CCAA
judge's decision. The QCA noted that even if the RVO
transaction was put to a vote of creditors as a plan of compromise
or arrangement, the objecting creditors would not be able to
determine the vote as they did not have significant claims. One of
the factors to consider in granting leave is the impact the appeal
would have on the CCAA case. The QCA noted that an appeal would
potentially hinder the progress of the CCAA proceedings and
compromise closing of the transaction, which would seriously
prejudice creditors.
Status
An application for leave to appeal this decision to the SCC has been filed and a leave decision is pending.
Takeaway
The decision of the QCA recognizes RVOs as a tool for insolvency
practitioners to affect the transfer of going concern operations in
a distressed context in line with the remedial purposes of the
CCAA.
Southern Star Developments Ltd. v Quest
University Canada, 2020 BCCA 364
Date of Decision: December 17, 2020
In January 2020, Quest University Canada (Quest) commenced
proceedings under the CCAA. Quest's interests included a
limited partnership agreement with Southern Star Developments Ltd.
(Southern Star), the general partner and Southern Star Developments
Limited Partnership (Southern Star LP). Southern Star LP
constructed certain residences on land owned by Quest. Quest and
Southern Star anticipated building a fifth residence on a vacant
lot (Lot E) owned by Quest. In anticipation of the fifth residence,
Quest and Southern Star entered into a ground lease by which Quest
leased the vacant lot to Southern Star and a sublease by which
Quest would lease the residence from Southern Star once built. The
ground lease was incomplete in many respects and was not registered
at the Land Title Office.
Since January 2020, Quest worked to identify prospective purchasers
for its real property assets, including Lot E. Following a court
supervised sale or investment solicitation process, Quest entered
into a sale transaction with Primacorp Ventures Inc. (Primacorp).
To facilitate the Primacorp transaction, Quest and Primacorp sought
the issuance of an RVO vesting off Southern Star's interest in
Lot E by declaring that any claims arising from the incomplete
ground lease shall not attach to Quest's assets that were to be
acquired by Primacorp in the share purchase, and enjoining Southern
Star from registering the ground lease against title to Lot
E.
Southern Star objected to the RVO for reasons that included that
(a) the court has no jurisdiction to grant the RVO under the CCAA
because the RVO was essentially a disguised disclaimer of a real
property interest (section 32(9)(d)) of the CCAA prohibits
disclaimer of leases of real property by a landlord), and (b) if
such jurisdiction exists under the CCAA, the relief sought was not
fair and equitable in the circumstances.
The supervising judge found that the court's jurisdiction to
grant a RVO lies in sections 11 and 36(6) of the CCAA, which allows
the court to exercise its jurisdiction to authorize the disposition
of assets free and clear of security, charges and "other
restrictions".
The supervising CCAA judge also found that the RVO was not
prohibited by section 32(9)(d) of the CCAA as a disguised
disclaimer of a real property interest. The parties did not intend
for the ground lease to become effective until certain conditions
were satisfied; namely that Southern Star would decide to build a
residence on Lot E and arrange financing to construct the
residence. The conditions were never satisfied and, accordingly, no
valid and enforceable lease existed with respect to Lot E.
The RVO appeared to be granted, at least in part, because of and
not in spite of, Southern Star's objection. Southern Star's
claim relative to other creditors created the possibility that
Southern Star could effectively veto a restructuring plan if one
had been required. Thus, a plan was not a viable option.
Additionally, a critical requirement of the Primacorp transaction
was that Quest remain a viable entity with the ability to grant
university degrees. Quest's ability to confer degrees was not
transferable. The RVO was the only transaction proposed that would
resolve the financial affairs of the debtor and avoid liquidation
or bankruptcy. In these circumstances, the court considered a RVO
to be appropriate.
The British Columbia Court of Appeal (BCCA) denied Southern
Star's application for leave to appeal, finding the prospect
that the BCCA would interfere with the supervising CCAA judge's
exercise of discretion was remote. As a general rule, decisions of
a supervising judge in a restructuring with respect to matters of
contractual interpretation are reviewed on a highly deferential
standard. An appeal court must be persuaded that the supervising
judge made palpable and overriding errors in their conclusion. The
BCCA also noted the disastrous consequences granting leave to
appeal would have on stakeholders affected by Quest's financial
circumstances as it was unlikely an appeal would be heard in the
timeframe required to preserve the transaction. Granting leave
would therefore frustrate the purposes of the CCAA.
Status
Leave to appeal this decision to the SCC must be sought by February 17, 2021.
Takeaway
This decision reinforces that, while not yet the most typical
solution in a CCAA proceeding, RVOs will be considered appropriate
where an RVO is the only transaction available to resolve the
financial affairs of a debtor company and facilitate the remedial
objectives of the CCAA.
Bellatrix Exploration Ltd (Re), 2020 ABQB
809
Date of Decision: December 22, 2020
Following the decision of the Court of the Queen's Bench of
Alberta discussed above, in which the Contract between Bellatrix
and the EP was found to be an EFC, Bellatrix ceased delivery of
natural gas under the Contract, despite being prevented from
disclaiming the Contract. The EP argued that this failure to
perform the terms of the Contract constituted a post-filing breach
by Bellatrix and that it was entitled to payment for its resulting
damages in priority to Bellatrix's secured creditor.
The EP submitted that if its claim was not found to be a priority
claim, the practical effect of Bellatrix's failure to perform
its duties under the Contract would be to render the disclaimer
rules of the CCAA meaningless. The EP contended that if CCAA
debtors are allowed to breach EFCs at will, the result is identical
to disclaimer: the solvent counterparty has a provable claim,
unsecured unless otherwise provided under the contract. The EP
submitted that if that were true, the prohibition on disclaimer of
EFCs in the CCAA would be without a purpose as the solvent
counterparty would not have performance of the contract and would
be left with the same remedy as it would have if the EFC were
disclaimed.
The court considered the protections offered to EFC counterparties
under the CCAA and found that the CCAA does not compel a CCAA
debtor to continue to perform an EFC that has not been terminated,
nor does it provide the counterparty with any priority for its
claim. The CCAA offers additional protection to solvent
counterparties to an EFC in that such counterparty has the ability
to terminate the EFC and crystallize the resulting loss, despite
the stay provisions of the CCAA.
Therefore, unlike regular contractual counterparties,
counterparties to EFCs can terminate the EFC if the insolvent party
fails to perform its duties under the contract, an action which the
EP chose not to take. The court declined to imply an obligation to
perform an uneconomic contract that may affect the ability of the
CCAA debtor to restructure, finding that if Parliament intended
this, more direct statutory language would be required.
Status
The EP has sought leave to appeal this decision to the Alberta Court of Appeal. The application for leave to appeal is scheduled to be heard on February 17, 2020.
Takeaway
Subject to review by the ABCA, where an insolvent debtor is prevented from disclaiming an EFC but nonetheless ceases to perform its obligations under an EFC, the solvent counterparty cannot compel performance of the contract. It can terminate, crystallize its losses and claim as an unsecured creditor for its damages.
UPDATE ON 2019 CASE LAW BULLETIN
DISTRIBUTIONS TO CREDITORS OF PROCEEDS IMPRESSED WITH A DEEMED TRUST UNDER THE EXCISE TAX ACT (CANADA)
Canada v. Toronto-Dominion Bank, 2020
FCA 80
Date of Decision: April 29, 2020
The Federal Court of Appeal (FCA) upheld the decision of the Federal Court rendered on May
25, 2018.
Like the Federal Court, the FCA found that, absent a bankruptcy,
the Excise Tax Act (Canada) (ETA) imposes an obligation on
secured creditors to repay money received out of proceeds of sale,
which, at the time the proceeds are received, are otherwise subject
to a deemed trust for unremitted HST/GST (i.e. federal/provincial
sales tax) under the ETA. This obligation is imposed by section 222
of the ETA which creates a deemed trust with respect to amounts
that are collected as goods and services tax. Subsection 222(3)
extends the trust to the property of the tax debtor and property of
the tax debtor held by any secured creditor of the person that, but
for a security interest, would be property of the debtor.
The FCA found that, when a bank lends money to a debtor with an
existing HST/GST liability and takes its security interest, the
debtor's property, to the extent of the tax debt, is already
deemed beneficially owned by the Crown. The FCA also found that
such bank cannot raise the defence of a bona fide
purchaser for value because, if such defence were available to a
secured creditor, the deemed trust provisions of the ETA would be
rendered meaningless.
In its decision, the FCA confirmed that the obligation to repay
money received from a debtor, which is otherwise subject to an
existing deemed trust for unremitted HST/GST, does not extend to
unsecured creditors who receive payments from a debtor in the
ordinary course on the basis that Parliament made a considered
policy choice to prioritize the protection of the Crown over the
interests of secured creditors.
Status
An application for leave to appeal this decision to the SCC was filed on July 6, 2020 and a leave decision is pending.
Takeaway
Subject to review by the SCC, this decision holds that absent a bankruptcy, secured creditors will be forced to disgorge an equivalent sum of money to money received that was subject to a pre-existing HST/GST deemed trust, upon demand from the CRA.
APPROVAL OF LITIGATION FUNDING AGREEMENTS AND LENDER SPONSORED CCAA PLANS
9354-9186 Québec Inc. v.
Callidus Capital Corp, 2020 SCC 10
Date of Decision; May 8, 2020
The SCC reversed the decision of the QCA and reinstated the decision of the Quebec Superior Court
(QSC).
In this case, a secured creditor of the debtor brought forward a
CCAA plan and proposed to vote on the plan in the same class as the
debtor's unsecured creditors on the basis that its security was
worthless. The proposed plan included a release of significant
litigation claims against the secured creditor in exchange for the
secured creditor funding a distribution to the debtor's
creditors.
The QSC found that in appropriate circumstances, it is possible for
a creditor to bring forward a CCAA plan and vote on it, but that in
this particular case, the creditor was using the CCAA plan for
improper purposes to secure the release of litigation claims
against it and should not be allowed to vote on the plan. The QSC
also approved a litigation funding agreement (LFA) to fund a
lawsuit against the same secured creditor.
The QCA reversed the decision of the QSC and found that there was
nothing improper about a creditor proposing a plan from which it
stands to gain in exchange for valuable consideration, and that
there was no justification on the facts to deny the creditor its
right to vote. The QCA also reversed the QSC's decision on the
LFA, finding that, in the circumstances, the LFA impacted
creditors' rights and, as such, constituted a plan of
arrangement that should have been submitted to creditors for
approval.
The SCC unanimously reversed the decision of the QCA and in doing
so confirmed a supervising CCAA judge's broad discretion to
assess and balance the remedial objectives of the CCAA, and to make
a variety of orders that respond to the factual circumstances of
each case, including an order to bar a creditor from voting on a
plan where such creditor is acting for an improper purpose. One
such improper purpose is where the creditor is seeking to use its
voting rights in a manner that frustrates, undermines or runs
counter to the remedial objectives of the CCAA. It is not, however,
an improper purpose for a creditor to vote in its own self
interest.
With respect to litigation financing, the SCC held that the
question as to whether litigation financing should be approved as
interim financing and granted any priority charge, is a
case-specific inquiry that should have regard to the text of
Section 11.2 of the CCAA and, more generally, to the remedial
objectives of the CCAA. The supervising judge is therefore best
placed to conduct this inquiry.
For more information, please see our May 2020 Blakes Bulletin: The SCC Has the Final Word:
Litigation Financing and Improper Purpose by a Creditor in
Restructuring.
ENFORCEABILITY OF MONETARY CONSEQUENCES FOR INSOLVENCY IN CONTRACT
Chandos Construction Ltd. v. Deloitte, 2020
SCC 25
Date of Decision: October 2, 2020
The SCC dismissed the appeal, confirming that the anti-deprivation
rule forms part of Canadian common law. The anti-deprivation rule
is a principle of common law that renders contractual provisions
void that remove value upon insolvency or bankruptcy that would
otherwise be available to creditors.
A contract between the contractor, Chandos, and a subcontractor
contained a clause (Insolvency Clause) stating that the
subcontractor would forfeit 10 per cent of the total contract price
in the event that, among other things, the subcontractor became
bankrupt. The subcontractor assigned itself into bankruptcy,
engaging the Insolvency Clause. At the time of bankruptcy, the
contractor owed the subcontractor C$150,000 and argued that this
amount should be reduced as a result of the Insolvency
Clause.
The SCC confirmed that the anti-deprivation rule exists in Canadian
common law and prevents contractual provisions from frustrating the
priority scheme of the BIA and the maximization of global recovery
for all creditors in accordance with the priorities set out in the
BIA. The SCC held that this common law rule had not been eliminated
by any decision of a court or by Parliament.
The SCC also concluded that the anti-deprivation rule has two
parts: the relevant clause is triggered by an event of insolvency
or bankruptcy, and the effect of the clause is to remove value from
the insolvent person's creditors, whether or not the intention
of the contracting parties was commercially reasonable. This is the
effects-based test.
Contractual provisions that eliminate property from the estate, but
do not eliminate value, may not offend the anti-deprivation rule,
nor will provisions whose effect is triggered by an event other
than insolvency or bankruptcy. The court also confirmed that the
anti-deprivation rule is not offended when commercial parties
protect themselves against a contracting counterparty's
insolvency by taking security, acquiring insurance or requiring a
third party guarantee.
Takeaway
The SCC has confirmed that the common law of Canada includes an anti-deprivation rule which applies in all commercial bankruptcy and insolvency proceedings.
PRIORITY OF DIP CHARGES
Canada v. Canada North Group Inc., 2019 ABCA
314
Appeal heard on December 1, 2020.
The Alberta Court of Queen's Bench considered whether a CCAA
court can order that charges, such as charges for
debtor-in-possession financing or administration charges, rank
ahead of the statutory deemed trust in favour of the Crown for
unremitted source deductions. The court held that it did have such
authority.
On appeal, the majority of the ABCA upheld the lower court's decision, ruling that the Crown's
interests under the statutory trust provisions of the Income
Tax Act (Canada), Canada Pension Plan (Canada) and
Employment Insurance Act (Canada) for unremitted source
deductions are deemed trusts, not true trusts (which, as a
proprietary interest, cannot be primed by court-ordered charges).
The Crown's interest in unremitted source deductions is
therefore akin to a security interest. The ABCA went on to hold
that, as the CCAA permits security interests to be primed, a CCAA
court can order that charges rank ahead of these deemed trust
interests.
Updated Status
Leave to appeal to the SCC was granted on March 26, 2020. The
appeal was heard on December 1, 2020. At this time, no decision has
been released
For permission to reprint articles, please contact the Blakes Marketing Department.
© 2020 Blake, Cassels & Graydon LLP.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.